BLOG: Selling your practice when you own the real estate
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Key takeaways:
- Private equity buyers will expect a practice to be free and clear of financing obligations upon closing.
- Selling physicians must address cross-collateralization between practice assets and real estate.
Selling a medical practice is a complex transaction that involves not only the assets of the practice itself but also implicates associated real estate.
It is not uncommon for physicians to own the real property where their practice operates; this arrangement is usually structured in such a way that the physicians own a separate legal entity that owns the real estate and serves as the landlord to the practice as the tenant. In private equity transactions with medical practices, it is unusual for the buyers to acquire the real estate, so there are important legal and financial considerations for physician owners, particularly if the real estate is subject to a mortgage that is cross-collateralized with the practice’s assets, which is often the case. Separating the collateral is essential because the private equity buyer will expect the practice to be free and clear of any such financing obligations upon the closing of the practice transaction.
Cross-collateralization
Many physicians will use the same lender to finance both their medical practice and the real property where the practice operates. In some cases, lenders will require cross-collateralization to secure the loans. Cross-collateralization occurs when a lender uses one set of assets — such as the practice’s accounts receivable or equipment — as collateral for the mortgage on the real property. Similarly, the real property may serve as collateral for the practice’s loans or lines of credit. This means that both the practice and the real estate serve as security for one or more loans. In other instances, rather than the practice’s assets being used to secure the mortgage on the real property, the lender will require the practice to guarantee payment of the mortgage.
This arrangement probably provided favorable financing terms for the physicians, but it complicates a sale of the practice. Because cross-collateralization ties the financial interests of the practice and the real estate together, these have to be separated when the practice is sold. The private equity buyer will want to ensure it is not assuming any obligations related to the real estate (which will remain owned by the physicians), and the physicians will want to ensure that the real property mortgage is no longer secured by the practice’s assets (which will be owned by the buyer). The private equity buyer will have its own sources of financing and will require any long-term financial obligations of the practice to be fully paid off and any associated liens to be released when the sale of the practice is consummated (or, in the case of a practice guarantee, the guarantee will need to be released by the lender).
Separating the collateral
Upon the closing of the sale of the practice, the practice will stand on its own (managed by the private equity buyer), and the real estate will stand on its own (owned by the physicians). Loan and mortgage agreements are complicated, and it can take substantial time and effort to negotiate new financing terms with the lender for the real estate that will continue to be owned by the physicians. The physicians (or more likely, their lawyers) will need to thoroughly review the loan and mortgage agreements for the real estate and the practice to understand the scope of the cross-collateralization and to determine which assets are tied to which loans and what steps are needed to separate the collateral. Next, the physicians will need to approach the lender to discuss releasing the practice’s assets as collateral from the real estate mortgage and releasing the real estate as collateral from the practice’s borrowings. In agreeing to separate the collateral, the lender may require the physicians to refinance the real estate mortgage (and the new interest rate may be higher than the original rate), provide substitute collateral to replace the practice assets that will no longer be available as collateral for the real estate mortgage, or provide other guarantees to the lender, such as personal guarantees of the physicians. In some instances, it may be necessary (or even preferable) for the physicians to use the proceeds from the sale of the practice to pay down or fully pay off the real estate mortgage.
If you are a physician who is interested in a private equity transaction and you also own the practice real estate, it is a good idea to start thinking about your real estate as early as possible. It is not uncommon for physicians to not remember or even be aware that the practice and the real estate have been cross-collateralized or that there is a practice guarantee. It can take a surprising amount of time to negotiate these matters with your lender, and you also need to coordinate with your private equity buyer.
In later blog posts, we will discuss considerations for physician landlords who will be leasing property to their private equity buyer, as well as regulatory compliance issues with real estate for health care providers.
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